The Scope of IMF Conditionality · The Scope of IMF Conditionality Randall W+ Stone Abstract...

The Scope of IMF ConditionalityRandall W+ Stone

Abstract International organizations are governed by two parallel sets of rules:formal rules, which embody consensual procedures, and informal rules, which allowexceptional access for powerful countries+ A new data set drawn from the IMF’srecords of conditionality provides an opportunity to study the bargaining process withinan important international organization and answer questions about the institution’sautonomy+ I find evidence of U+S+ influence, which operates to constrain condition-ality, but only in important countries that are vulnerable enough to be willing todraw on their influence with the United States+ In ordinary countries under ordinarycircumstances, broad authority is delegated to the IMF, which adjusts conditionalityto accommodate local circumstances and domestic political opposition+ The IMF hasrefrained from exploiting the vulnerability of particular countries to maximize thescope of conditionality+

International organizations have become increasingly important actors in inter-national politics+ They have proliferated, have expanded in membership, haveacquired new legal enforcement powers, and have extended their reach into thedetails of domestic political economy in their member states+ A few, including theInternational Monetary Fund ~IMF, or simply the Fund!, command significantresources and wield considerable authority+ Some critics have argued that theseinternational organizations are sufficiently autonomous to create a democratic def-icit at the international level, as they pursue a vision of “undemocratic liberal-ism+”1 Other critics have argued that international organizations are nothing morethan instruments in the hands of powerful states+2

These critiques, of course, cannot simultaneously be true, and both run intodifficulties+ The puzzle that the rogue-agency view cannot explain is why theprincipals have chosen to delegate so much authority+ In principal-agent terms,this view posits that both screening and monitoring have failed: the principalsare unable to select agents with preferences similar to their own, and are unable

Collaboration with Ashoka Mody, comments from Jim Boughton, Morris Goldstein, Robert Keo-hane, Bessma Momani, Jacques Polak, Miguel Savastano, Roland Vaubel, James Vreeland and JohnWilliamson, and research assistance by Adrian de la Garza in compiling the conditionality data aregratefully acknowledged+

1+ Barnett and Finnemore 2004+2+ See Krasner 1985; and Strange 1988+

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International Organization 62, Fall 2008, pp+ 589–620© 2008 by The IO Foundation+ doi:10+10170S0020818308080211

or unwilling to exert effective control+ In this case, rational principals shouldrefuse to delegate+3 I find little support for the best developed of the rogue-agency theories, which are derived from a public choice perspective+4 The puzzlethat the power politics school is unable to explain is why weaker states partici-pate in international organizations, if their policies simply reflect the preferencesof the powerful+ In order for institutions to be useful to powerful states, theymust elicit voluntary participation, which means that there must be sufficient agree-ment about common purposes that weaker states can expect to benefit fromcooperation+

This essay develops an alternative view, which I call informal governance+ Inter-national organizations operate according to two parallel sets of rules: formal rules,which embody consensual procedures, and informal rules, which allow excep-tional access for powerful countries+ In this view, the danger embodied in delega-tion is not that the agency will run out of control, but that it will be captured bythe most powerful state in the system+ Consequently, states will only agree to del-egate extensive powers to international organizations when they expect to sharebroadly similar objectives+ During ordinary times, the organization produces pre-dictable policies that express the consensus view of its most influential members,and it enjoys broad discretion within its zone of delegation+ However, the leadingstate—the “G1,” as the United States is often called within the IMF—may inter-vene and assume temporary control when urgent strategic objectives override itsinterest in the organization’s long-term goals+ Informal governance practices allowit to retain decisive influence in the organization while shedding most of the for-mal levers of power+ The other leading states tolerate these practices, so long asthey are not exploited too frequently, because they make the institution more valu-able to the United States and make it less inclined to exercise outside options+Informal influence must be exercised with discretion, however, in order to avoidundermining the legitimacy of the organization; and there is growing evidencethat the United States has created a crisis of legitimacy in the IMF and other inter-national organizations by abusing its privileged role+

I test hypotheses derived from this model for the case of the IMF using newlyavailable data on the conditionality of IMF programs from 1992–2002+ The impli-cation for the IMF is that one should expect conditionality—the packages of pol-icy reforms that countries promise to undertake to receive financial support fromthe Fund—to reflect long-term economic policy priorities during normal times inordinary countries, but to reflect U+S+ interference during crises in politically impor-tant countries+ Two corollaries follow from the argument that the motivation forthe United States to intervene is to provide a favor to a valued client+ First, U+S+intervention should reduce, rather than increase, conditionality+ Second, becausecountries draw on their reserves of influence with the United States only when

3+ Hawkins et al+ 2006+4+ See Vaubel 1986; and Dreher and Vaubel 2004+

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590 International Organization

the stakes are high, the effects of U+S+ influence should appear only when IMFsupport is particularly important to the borrower+ I find support for each of thesehypotheses+ Furthermore, the strength of U+S+ intervention depends on the insti-tutional capacity of the borrower, which I interpret to mean that U+S+ inter-vention depends on the balance of influence between the aid recipient and thedonor+

I introduce three methodological innovations+ First, the dependent variable mea-sures the substantive scope of conditionality, rather than the raw number of con-ditions+ I show that IMF programs vary considerably in substantive focus, andthat their breadth responds to domestic political constraints+ Second, I use a bivar-iate probit with partial observability model of participation in IMF programs togenerate measures of bargaining power+ Third, I introduce a new measure of statecapacity, which is derived from the pattern of missing data reported to the IMF+

Informal Governance

The degree of the IMF’s autonomy is controversial+ The IMF was not designed tobe the independent world central bank that Keynes envisaged; from the begin-ning, its members, most notably the United States, expressed a preference for amember-controlled organization rather than a supranational one+5 However, theFund’s management and staff have gradually gained autonomy from the sharehold-ing countries represented on the Executive Board, and critics of the IMF fear thatthis autonomy goes too far+6

Conditionality is not stipulated in the IMF’s Articles of Agreement and wasoriginally instituted at the insistence of the United States and over the objectionsof the rest of the membership+ After the collapse of the Bretton Woods system offixed-exchange rates, the Fund reinvented itself as an agency with extensive involve-ment in the politics of development, and managing conditionality became a moreimportant part of its mandate+ As late as the 1970s, only 26 percent of IMF loandisbursements involved substantial conditionality, but the Latin American debt cri-sis in the 1980s and the expansion of lending to Africa increased this figure to 66percent by the end of the 1980s+7 In the subsequent decade covered by the presentstudy, the number of conditions specified in an IMF program steadily climbed asthe Fund sought to manage the transition from state planning to the market informer communist countries and grappled with the importance of financial sectorissues in the East Asian crisis+ At the same time, the scope of conditionality ven-tured into areas of domestic economic structure and policies outside the Fund’s

5+ Pauly 1997+6+ Martin 2006+7+ Boughton 2001, 561+

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The Scope of IMF Conditionality 591

traditional purview and competence+ The bureaucratic rent-seeking view,8 whichis inspired by public choice analysis and influences prominent policy recommen-dations such as the Meltzer Commission Report,9 views this as an expression ofan organizational interest in promoting mission creep+

An alternative critique assumes that international organizations simply reflect theinterests of a few powerful states, or of one+ An impressive amount of corroborat-ing evidence indicates that major shareholders are able to skew the distribution ofIMF loans and to subsequently undermine the enforcement of conditionality+10 Sim-ilarly, countries that enjoy special relationships with major IMF shareholders maybe able to avoid extensive conditionality when they borrow from the Fund+11 Inalmost all cases, the evidence indicates that the powerful shareholder that exer-cises influence over the IMF is the United States+12

One interpretation that is consistent with this evidence is that the IMF is simplya tool in the U+S+ arsenal+ The IMF’s Articles of Agreement, its system of indirectrepresentation of members, its formal lending criteria, and its weighted votingmechanism—its formal governance institutions, in short—are components of apolite fiction that hides its true purpose+ To the extent that these arrangements mat-ter at all, they are epiphenomenal, because they reflect the distribution of power+13

The puzzle for this power-politics interpretation, however, is explaining why weakstates consent to participate+ Why should weak states participate in an arrange-ment skewed toward the interests of the strong, and why should secondary powerstolerate an arrangement that disproportionately favors the leader of the system?

I propose an alternative model, which I call informal governance+ The buildingblocks of the argument are: ~1! legitimacy defined in terms of voluntary participa-tion; ~2! conditional delegation; ~3! common long-term interests and conflictingshort-term interests; and ~4! formal and informal governance of internationalorganizations+

In order for international institutions to serve anyone’s interests, they must enjoyminimal legitimacy, because they must elicit voluntary participation+ Institutions

8+ See Vaubel 1986; Dreher and Vaubel 2004; Przeworski and Vreeland 2000; and Vreeland 2003+Starting from a different methodological point of view, Barnett and Finnemore 2004 argue that mis-sion creep is a consequence of the bureaucratic nature of international organizations, which causesthem to respond to failure by expanding their definitions of the problems to be solved+

9+ Meltzer 2000+10+ See Thacker 1999; Barro and Lee 2002; Dreher and Jensen 2003; Eichengreen, Gupta, and Mody

2006; and Stone 2002 and 2004+ For a review of the recent quantitative literature on IMF lending, seeSteinwand and Stone 2008+

11+ See Polak 1991; Gould 2003 and 2006; Copelovitch 2004; and Dreher and Jensen 2007+12+ The only systematic quantitative evidence of interference by countries other than the United

States is from the author’s work on Africa, which found that France and Britain intervened on behalfof some of their former colonies with which they maintained close political ties; see Stone 2004+ Sub-sequent interviews at the Fund have confirmed this pattern but underscored that it is limited to Africa+In other regions, the United States firmly repulsed other Group of 7 ~G7! countries that sought tointerfere, as Japan discovered in Indonesia and Korea+

13+ Krasner 1985+

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are useful in order to coordinate expectations, define rules, and facilitate collec-tive action when there are common interests to be achieved through collaboration+In order for this to be the case, institutions have to be designed in such a way thatall of their members benefit from participating, if not in every instance, at least inexpectation+ From this perspective, the design of international organizations dependsat least as much on the distribution of interests in the issues at stake as it does onthe nature of the transaction costs involved+14 The allocation of voting rights hasto balance the fact that more powerful states have more attractive outside options,while even weak states must be offered enough to prefer participation to exit+ Theformal allocation of voting rights does not fully describe the distribution of author-ity within the institution, because powerful states can exert informal influence+However, formal rules and standard procedures determine the status quo that pre-vails when the leading state chooses not to intervene, and it cannot intervene toooften without undermining the value of the organization+

This implies that IMF decision making follows a two-track model, which I termconditional delegation+ In ordinary times, the United States and the other share-holders have no compelling interest in intervening in the details of conditionality,and the Fund creates policies autonomously+ The major shareholders have a com-mon interest in promoting prudent macroeconomic management, market-orientedeconomic reforms, and trade openness, and the Fund is a technocratic agency withstaff selection procedures that lead it to pursue these objectives, so there is noneed to monitor its daily activities closely+ Delegation is optimal for the principalsbecause the agent’s type is known+ However, the shareholders also have fluctuat-ing short-term strategic interests in particular countries, and for the system leaderthese interests can be sufficiently intense to override its economic policy prefer-ences+ In order to make delegation and consensual decision making tolerable forthe United States, therefore, the other leading states acquiesce in an arrangementthat allows the United States to assume temporary control of the organization whenits core interests are affected+

This arrangement may lead to opportunism, so delegating more authority to inter-national organizations increases the danger that the institution will be captured bythe leading state+ I illustrate this below with reference to the IMF, but it has broadimplications for the theory of delegation that differ from the received wisdom+15

Whereas functionalist theories of delegation emphasize variations in transactioncosts and deliberate design of institutions to balance the costs imposed by agencyand collective action, this view suggests that variations in delegation respond tovariations in the intensity of long-term conflicts of interest+Where conflict of inter-est is perceived as systematic and lasting, as in trade, weaker states will be reluc-

14+ Transaction costs have been linked to centralizing or decentralizing decision making, determin-ing the size of IO membership, determining the duration and scope of agreements, and legalizing com-mitments or leaving them informal+ See Abbott and Snidal 2000; and Koremenos, Lipson, and Snidal2001+

15+ Hawkins et al+ 2006; and Koremenos, Lipson, and Snidal 2001+

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tant to delegate much rulemaking authority to agencies that subsequently might becaptured by their stronger rivals+ Indeed, one sees that the World Trade Organiza-tion ~WTO! has much more limited autonomy than the IMF+ The WTO is limitedto adjudicating disputes about the application of existing rules, rather than to mak-ing rules, and the legalization of the WTO dispute resolution procedure was vig-orously resisted by developing countries, which anticipated—correctly, as it turnsout—that panels would rarely rule in their favor+16 Similarly, European states havedelegated substantial authority to the European Union in areas where they havebroadly congruent interests but have allowed it only a limited role in setting for-eign policy, where national differences are deeper and more lasting+ In this view,the relative autonomy of international financial institutions is not a result of dis-agreement among the major shareholders,17 but of the fundamental agreement ofthe shareholders on the general principles of financial stabilization, market open-ness, and liberal economic reform+

This is not to say that there is no conflict among the major players in inter-national finance, but rather that the conflict has less to do with the content of therules than with when to make exceptions to them+ In particular cases, shareholdersmay find it convenient to use IMF programs as an inexpensive form of foreign aid+18

In an emergency, the IMF can mobilize more resources and act more expeditiouslythan the U+S+ Agency for International Development, and the IMF can lend with-out U+S+ congressional approval+ The United States has drawn on its influence atthe Fund to attempt to induce recipient governments to support its foreign policyobjectives, and at times it has pressured the Fund to be lenient because it has beenreluctant to risk destabilizing friendly regimes+ Although the United States sharesan interest in stabilizing the global economy with the other Group of 7 ~G-7! coun-tries, it disagrees with them about how important other interests are—such as stra-tegic objectives in the Middle East—that are extraneous to the concerns ofinternational finance but temporarily come into conflict with the long-term objec-tives of the IMF+ Common long-term interests in promoting economic develop-ment and open markets suffer when the Fund’s priorities are subordinated to otherobjectives, because this undermines the credibility of the loans-for-reforms contract+

How does a country that holds only 17 percent of the voting power in an orga-nization exercise a controlling interest in its activities? The United States doesthis through informal participation, in a way that is similar to the way minorityshareholders can control publicly held corporations if they exert sufficient effort+The smaller shareholders are content to free-ride, because they know that theirinterests are unlikely to come into conflict with those of the United States in mostcases+ Furthermore, the United States has an overwhelming advantage over other

16+ Barton et al+ 2006+17+ Martin 2006 argues that IMF autonomy arises from disagreements among the major sharehold-

ers, which create a “multiple principal” problem+18+ Marc Leland, Assistant Treasury Secretary in the Ronald Reagan administration, referred to the

IMF as “a convenient conduit for U+S+ influence”; see Cohen 1986, 229+

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states in its capacity to participate informally in IMF decision making, and theinformal practices of the Fund amplify that advantage+ In particular, two practicesthat might appear to strengthen the Fund’s autonomy—unanimity voting and thecentralization of information—in reality serve as backdoors that allow the UnitedStates to exert a controlling influence+

According to the IMF’s formal procedures, the managing director exercises aremarkable degree of gate-keeping power and proposal power as chair of the Exec-utive Board+ Voting on the Executive Board is almost always unanimous, andamendments are not allowed to country-lending items because they have been nego-tiated with country authorities before they are brought to the Board for ratifica-tion+ In effect, the managing director can control the agenda and choose the mostpreferred policy from the feasible set+ However, informal participation allows influ-ential shareholders to control the substance of the management proposal, assum-ing the formal proposal-setting prerogatives of the chair for themselves+ This allowsthe United States to exert effective control by participating much more activelythan the other shareholders+ The United States has a tremendous organizationaladvantage over other countries because it has a more extensive diplomatic corps,particularly important private financial institutions, numerous advantages in gath-ering information, and all of the advantages of having the IMF located in the U+S+capital, in addition to issuing the international reserve currency and commandingthe resources of a superpower+ With the exception of France and England, whichexercise substantial influence in their respective spheres in Africa, the United Statesis usually the only active participant+

These advantages are increased by rules that centralize information+ There areextensive formal rules that insulate the design of conditionality from participationby shareholders through their executive directors+ Except for the borrower’s rep-resentative, executive directors do not participate in missions to countries or thenegotiation of programs+ In addition, they are not privy to the confidential docu-ments that are key to the negotiations, the mission briefs that determine the param-eters of the negotiator’s discretion and the back-to-office reports about the progressof negotiations+19 This centralization of information generally prevents executivedirectors from influencing conditionality, but it does not prevent the United Statesfrom being fully informed+ For example, the U+S+ executive director routinely inter-views chiefs of mission before and after missions to Latin American countries,and in extraordinary cases such as Mexico, Russia, Indonesia, and Korea, seniorU+S+ Treasury officials were intimately involved in the details of the negotia-

19+ This may seem surprising; after all, the principal should want full access to information in orderto monitor the agent effectively+ When interviewed, however, IMF officials unanimously agreed thatthese documents were never provided to executive directors+ Executive directors reported that theynever asked to see them, and they would not expect staff to comply if they did+ There was broadagreement that these rules were necessary to safeguard the integrity of the bargaining process, becausethe directors could not commit not to reveal the staff ’s bottom line to the borrowing country if theyknew what it was+

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tions+20 Confidentiality provides the IMF management with an information advan-tage over the Executive Board and a measure of autonomy21 but simultaneouslyallows the United States to centralize control+

The model of informal governance is broadly consistent with the power politicsview that international organizations reflect U+S+ influence, but it generates sev-eral testable hypotheses that are not implied by that perspective+ First, the modelpredicts that variation in delegation reflects variation in conflicts of long-term inter-ests, so that institutions such as the IMF, which preside over issues in which con-flicts of interest are short-term, should enjoy substantial autonomy within theirzones of delegation+ Second, it predicts that U+S+ influence should be exercised toreduce conditionality, rather than to expand it, because the incentive for partici-pating in the process is to accommodate the interests of an important client+ Analternative possibility is that U+S+ intervention takes a form similar to trade policy,and that narrow, well-organized private-sector interests lobby to insert conditionsinto programs+22 To the contrary, the informal governance model assumes thatprivate-sector interests in developed countries are generally well-served by thedefault option of allowing the Fund to develop policy autonomously, so interestgroups have weak incentives to organize+ The United States participates when itssecurity or broader strategic interests become involved, because these interests arenot ordinarily represented in IMF objectives+

Third, the model predicts that U+S+ participation in program design should beskewed toward strategically important countries+ Using informal influence to rollback conditionality is costly because it overrides long-term U+S+ economic inter-ests and because it undermines the legitimacy of the IMF+ Consequently, it willonly be done on behalf of important countries, when foreign policy objectivesoverride economic analysis+ In Argentina in 2001, for example, the U+S+ StateDepartment and National Security Council pushed for extending loans, while theU+S+ Treasury was initially reluctant+23 Fourth, these strategic interests only becomeoperative when securing IMF financing becomes a high priority for the borrower+The U+S+ motive for intervening in the Fund’s operations is to respond to a clientstate’s request for support+ From a borrower’s perspective, influence with the UnitedStates is a valuable resource, which should only be drawn down when the stakesare high+ Thus, the effects of the borrower’s strategic importance should be con-ditional on the borrower’s external vulnerability+ Together, the hypotheses that U+S+influence should be used selectively, that that it should reduce conditionality, thatit should only be available to important countries and that it should only be usedwhen those countries are vulnerable make possible a sharp test of the informalgovernance model+

20+ IEO 2003+21+ Martin 2006+22+ Gould 2003 and 2006+23+ See Blustein 2005; and Taylor 2007+

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Alternative Hypotheses

Implicit or explicit in most critiques of IMF autonomy is a bureaucratic rent-seeking view of international institutions: the Fund is an autonomous agent thatseeks to maximize conditionality, and once released from Pandora’s box, it exploitsopportunities for conditional lending to promote its own influence in the inter-national system+24 This is parallel to arguments that the European Commissionand the European Court of Justice have acted strategically to promote Europeanintegration and the influence of European institutions, sometimes over the objec-tions of national governments+25 The principals, in this view, are unable or unwill-ing to monitor the behavior of their agent very closely, so the Fund enjoys widelatitude to select loan recipients and to design conditionality+26 Expanding the num-ber of loan recipients and the invasiveness of its preferred policy reforms makesthe IMF a more vital player in the international economy, and thereby promotesthe careers and improves the outside options of its employees+ Furthermore, someargue that the Fund has an interest in expanding the number of policy variablesthat it attempts to control and choosing policy targets that are difficult to monitorin order to prevent effective monitoring by its own principals+27 The IMF has themost discretion to determine the scope and nature of conditionality when a country’sshort-term economic prospects critically depend on receiving IMF financial sup-port+ Therefore, if the IMF attempts to maximize conditionality, the conditionsshould be most extensive when borrowers are most vulnerable+ I test this propo-sition+ The null hypothesis is that, rather than attempting to maximize condition-ality, the IMF seeks to negotiate an optimal package of reforms based on a technicalconception of conditionality, reflecting national circumstances+28 In this case, con-ditionality need not be associated with the Fund’s bargaining leverage+

A domestic-politics variant of this approach focuses on agency problems withinthe borrowing country, emphasizing that Fund policies undermine political partici-pation and representation in the countries to which the IMF lends+ In this view,governments participate in Fund programs to escape accountability to voters orotherwise evade domestic political constraints+ Critics have argued that govern-ments engage in IMF programs to gain leverage vis-à-vis domestic opponents,which they use to depress real wages and transfer wealth to economic elites+29 Forexample, a government might negotiate a program with the IMF that represents itstrue preferences but then blame the Fund for imposing these policies on it againstits will+ This allows the government to confront domestic actors that are not privy

24+ See Vaubel 1986; and Dreher and Vaubel 2004+25+ See Garrett 1992; and Sandholtz and Zysman 1989+26+ Martin 2006 argues that distributional conflict among the shareholders leads to a multiple prin-

cipal problem+27+ Vaubel 1991, 232–33+28+ This is consistent with Barnett and Finnemore 2004, who argue that Fund staff are rational-

technical experts who are sincerely motivated to solve problems, rather than rent seekers+29+ See Vaubel 1986; and Vreeland 2002 and 2003+

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to the negotiations with a fait accompli—they must either support the government’sprogram in spite of their misgivings or forfeit IMF support—while making it moredifficult to organize punishment+ The testable implication of this argument is thatgovernments have incentives to accept more intrusive conditions if they are con-strained by legislative opposition or numerous coalition members, because condi-tions are a means for leaders to nullify the constraints of domestic politics+ Thenull hypothesis—also an influential view—is that the borrowing country prefersfewer conditions and will exercise any leverage it has to reduce the scope of con-ditionality+30 In this view, represented by the literature on two-level games, domes-tic constraints represent bargaining leverage and should be associated with lessintrusive forms of conditionality+31

Describing IMF Conditionality

Twenty-five years ago,Williamson summarized the charges of the IMF’s critics asincluding a doctrinaire adherence to free markets, insensitivity to individual coun-try conditions, and the overriding of national sovereignty+32 The Fund continues tobe criticized for applying one-size-fits-all policy prescriptions without sensitivityto context, ignoring borrowers’ domestic political constraints, and promoting theinterests of major shareholding governments ~or their elites! at the expense of bor-rowing countries’ needs+33 Especially following the Asian crisis, the IMF was faultedfor conditionality that sought to control too many policy variables, many of whichextended beyond its traditional areas of competence;34 moreover critics claimed,such conditionality did not help and may even have hurt economic prospects+35

Sympathetic insiders and the Fund itself have conceded that conditionality may,as a consequence of these shortcomings, have been superficially implemented,requiring a shift to greater “ownership” of reform by country authorities and“streamlining” of its content+36

30+ See Krasner 1985; and Dreher and Vaubel 2004+31+ See Putnam 1988; and Haggard and Kaufman 1995+32+ Williamson 1983+33+ See Meltzer 2000; Easterly 2001; and Stiglitz 2002+34+ See Feldstein 1998; Hills, Peterson, and Goldstein 1999; and Goldstein 2001+35+ Feldstein 1998+ An extreme example of the proliferation of conditions is the program intro-

duced in Ukraine on the eve of its financial collapse in 1998, which contained 227 prior actions andperformance criteria ~Ukraine 1998!+ Goldstein 200 judged conditionality to have been excessivelyintrusive during the Asian crisis+ Based on their conclusion that IMF-supported programs are associ-ated with lower GDP growth rates, Przeworski and Vreeland 2000 inferred that lending is conditionedon inappropriate policy measures+

36+ Khan and Sharma 2001; and Drazen 2002 call for greater ownership; and IMF 2005 introducedthe initiative to streamline conditionality+ Even studies showing beneficial outcomes of IMF programs,while recognizing the value of commitment to policy reform, question whether the form or scope ofconditionality is crucial to achieving the needed commitment; see Mody and Saravia 2006+

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Much of this debate has taken place in the absence of quantitative data aboutthe content of conditionality+ This article uses a new data set extracted from theIMF’s Monitoring of Agreements Database ~MONA!, which covers the ninety-sixcountries that participated in IMF programs between 1992 and 2002+ I reorga-nized the data in terms of country-month units+ Thus, for each country-month, Iidentify whether the country was participating in an IMF program and, if so, whatperformance criteria were currently applicable+ The database codes IMF condition-ality in nineteen categories, representing the most frequently applied types, rang-ing from fiscal and monetary policy to exchange rate restrictions and structuralreforms+

The data measure quantitative macroeconomic performance criteria and struc-tural benchmarks, which are the key yardsticks of compliance with conditionality+Performance criteria are formal conditions that must be met by a correspondingtest date, or officially be waived by the Executive Board in the event of noncom-pliance, in order for scheduled disbursements to be made under IMF programs+Benchmarks are more specific structural reforms, such as privatization, deregula-tion, and tax reform, that are used to determine a country’s compliance with aprogram but do not automatically call for suspending IMF support in the event ofnonfulfillment+ This measure of conditionality excludes prior actions, which areconditions that must be met before the Executive Board approves a program+Excluding prior actions means that I focus on the elements of conditionality that acountry promises to implement in the future when it contracts with the Fund, ratherthan on policy concessions that have been implemented to obtain a program+

The dependent variable of primary interest is the number of categories of con-ditions subject to test in a particular review+ This measure of conditionality cap-tures the scope—or, to the Fund’s critics, the intrusiveness—of conditionality+ Thisdefinition of conditionality focuses on the range of obligations that constrain coun-try authorities at any given point in time+ This measure of conditionality has advan-tages over assessments of conditionality that depend, for example, on letters ofintent+37 As IMF authors have emphasized, conditionality evolves over the courseof a program in response to country policies and unanticipated events, so the scopeof a program contained in a letter of intent may give a misleading snapshot ofwhat is really a moving target+38

In an average month, six categories of conditions were subject to test at thenext review; about two-thirds of the time, at least two and no more than ten typesof conditions were under review+ In about 11 percent of program months, no con-ditions were tested because the program remained open after the final review+ Fig-ure 1 illustrates the variation in the number of categories of conditionality applied+For the statistical analysis of conditionality reported below, I include only obser-vations that fall on test dates to avoid inflating the number of observations+

37+ See Gould 2003; Dreher and Jensen 2007; and Copelovitch 2004+38+ Mussa and Savastano 1999+

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Table 1 illustrates the substantive variety of IMF conditionality+ Some aspectsof IMF conditionality are very consistent: domestic credit is constrained and reservetargets are set about half the time, and there is almost always some limit on publicdebt or government spending, although the forms of those restrictions vary+ Thereis a strong emphasis on avoiding foreign debt arrears+ Some programs involveextensive regulation of public spending, taxation, borrowing, and the maturity struc-ture of domestic and foreign debt, while others simply set deficit targets+ How-ever, the frequent criticism that the IMF systematically promoted fixed-exchangerate regimes in the 1990s is not supported by the data on conditionality+39 To thecontrary, the data support a different criticism: the Fund is too neutral with respectto exchange rate policy, and allows itself to be captured by country authoritiesthat are determined to defend overvalued exchange rates, as happened in Russia in1998, Brazil in 1999, and Argentina in 2001+40 Although structural conditions ofsome sort are being tested 43 percent of the time, even this coarse breakdown ofstructural reforms into six categories indicates that structural conditionality variesenormously across countries+ In fact, the way I have aggregated the data under-states the case+ Experience with the raw data reveals that many structural reforms

39+ See Hills, Peterson, and Goldstein 1999; Meltzer 2000; and Stiglitz 2002+40+ See Blustein 2001; IEO 2003 and 2004; and Mussa 2002+

FIGURE 1. Scope of conditionality ( frequencies of country-months in which eachnumber of categories of conditions applied)

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are very country-specific and refer to proper names of institutions and organiza-tions to be reformed, so a sixfold categorization of structural reforms exaggeratesthe similarity of conditions across countries+

The scope of conditionality varies across types of IMF programs+ Stand-by facil-ities ~SBAs! are typically one- to two-year programs offered to middle-income bor-rowers, and they test an average of five categories of conditions per month; extendedFund facilities ~EFFs! are typically three-year arrangements with more ambitiousgoals, and they average seven test categories+ Extended structural adjustment facil-ities ~ESAFs! and poverty reduction and growth facilities ~PRGFs! are long-termprograms for poor countries, and their average levels of conditionality were inter-mediate between the other two+ The replacement of the ESAF program by the PRGFushered in new poverty-reduction targets and increased the emphasis on debt arrears,but otherwise generally scaled back the application of conditionality+

A principal components analysis of the categories did not reveal any clear pat-tern of clustering of types of conditions; thus, it is not the case that conditionality

TABLE 1. Coverage of conditions under IMF programs, 1992–2002

All programs SBAs EFFs ESAFs PRGFs

Monetary policyDomestic credit 0+53 0+54 0+69 0+54 0+42Balance of payments reserve test 0+53 0+58 0+75 0+46 0+42

Fiscal policyFiscal deficit 0+37 0+39 0+61 0+29 0+35Domestic public borrowing 0+47 0+36 0+47 0+63 0+50Domestic public debt 0+34 0+27 0+31 0+43 0+40Long-term foreign debt ceiling 0+62 0+59 0+77 0+65 0+56Long-term for debt subceiling 0+47 0+43 0+62 0+48 0+49Short-term debt 0+58 0+54 0+75 0+60 0+60Fiscal actions 0+36 0+26 0+44 0+45 0+47

Debt serviceExternal arrears limit 0+20 0+15 0+14 0+32 0+12No new external arrears 0+60 0+40 0+64 0+77 0+95

Exchange ratesExchange rates 0+05 0+06 0+08 0+02 0+03Foreign exchange operations 0+03 0+04 0+02 0+02 0+05

Structural reformsPublic-sector reform 0+13 0+04 0+10 0+22 0+27Banking 0+17 0+18 0+22 0+20 0+22Privatization 0+09 0+03 0+03 0+18 0+13Price controls 0+07 0+01 0+11 0+13 0+13Trade actions 0+02 0+01 0+02 0+04 0+07Others 0+07 0+03 0+03 0+12 0+13Observations (months) 7,203 2,664 1,366 2,811 1,154

Notes: EFFs � extended fund facilities+ ESAFs � extended structural adjustment facilities+ PRGFs � poverty reduc-tion and growth facilities+ SBAs � stand-by facilities+

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follows, for example, one, two, or more typical patterns+ Rather, conditions areapplied idiosyncratically and apparently in response to local circumstances+ Onlyone significant component emerged, and it reflected the number of categoriesapplied, so in the analysis that follows I use the number of categories of condi-tions as a measure of the breadth of conditionality+

Participation in IMF Programs

The content of conditionality in IMF programs is the subject of bargaining betweenthe Fund and the borrower, and this theoretical setting has implications for theappropriate econometric strategy+ Because bargaining involves the strategic use ofthreats to block agreement, I use data on which countries participate in IMF pro-grams to generate proxies for bargaining power, which I subsequently use to testfor bargaining effects+ I first estimate the probability of participating in an IMFprogram+ I use a bivariate probit model with partial observability, which, unlikesingle-equation selection models, captures the fact that participation depends ondecisions made both by the IMF and by the borrowing country+41 This is a modelof onset of IMF programs, so the estimation sample excludes months in which aprogram is already in place+ The model generates two predicted marginal proba-bilities: the probability that a country applies to the IMF for support and the prob-ability that the IMF is willing to approve a program+ These probabilities can beinterpreted as measures of expected utilities that the researcher cannot observe:governments that are motivated to accept IMF financing are more likely to apply,and countries that the IMF or its principals have incentives to support are morelikely to be approved+42 The predicted probabilities therefore measure the bargain-ing power of the borrower and the Fund, respectively+ In the second stage of theanalysis, I analyze the substantive scope of conditionality+ I employ a negativebinomial event count model, where the dependent variable is the number of cat-egories of conditions that apply at each test date during a program+

41+ This model is due to Poirier 1980+ Przeworski and Vreeland 2000 and 2002; and Vreeland 2003use a dynamic version in studies of IMF conditionality+ The model is bivariate probit because thedependent variable is modeled as the product of two dichotomous decisions ~one made by the countryand the other by the IMF!+ It is a model with partial observability because I only observe oneswhen both the country and the IMF choose a program; when I observe zeros, I do not know whetherthe country, the IMF, or both rejected a program+ In contrast to Vreeland 2003, 105– 6, I do not assumethat the two decisions are independent, so the model includes a parameter for the correlation betweenthe error terms+ The Przeworski and Vreeland models are dynamic because they estimate them sepa-rately for subsamples of years in which countries did and did not have an IMF program in the previousyear+ I likewise run the estimation separately, but because I am using monthly data and am interestedin onset probabilities, I only report the results for the initiation decision+

42+ The bivariate probit estimates two latent variables that represent the expected utility of partici-pation to each actor, and the predicted probabilities represent the probabilities that these utilities arepositive in each observation+

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The dependent variable in the first stage of the analysis is an indicator variablecoded 1 when a country participates in a program and 0 when it does not+ I treatthis variable, z, as the product of two decisions: di, t

G , the government’s decision toparticipate, and di, t

IMF , the IMF’s decision to approve a program+ One observes zi, t

� 1, only when di, tG � 1 and di, t

IMF � 1+ The sample includes only observations inwhich there is no prior program in force, so the model explains program initiation+

The government’s value of participating in an IMF-supported program is ex-pressed by the latent equation:

di, tG* � Xi, t

G bG � «i, tG

Similarly, the IMF’s value of participation is:

di, tIMF* � Xi, t

IMFbIMF � «i, tIMF

The probability of observing z � 1 is the probability that both latent variables arepositive, where the disturbance terms ~«i, t ! are distributed normally with correla-tion r+ If F denotes the bivariate standard normal distribution, then the probabil-ity of program initiation is:

pi � F~Xi, tG bG , Xi, t

IMFbimF ;r!

Several macroeconomic and domestic political variables, as well as time seriescontrols, are assigned to both equations, implying that they influence both deci-sions ~see Table 3, below!+ For example, an extensive literature on participation inIMF programs finds that the level of foreign reserves, changes in reserves, andchanges in the exchange rate are correlated with program initiation+ In addition, Iallow for the degree of democracy, the number of countries participating in pro-grams, and the government’s legislative support, left-right policy inclinations, andnumber of coalition partners to influence both decisions+ At this point, however, aset of priors is needed to identify the latent equations, which allows one to distin-guish the country’s decision to apply for a program from the IMF’s decision toextend support+ Multiple identification restrictions are required for global identi-fication+43 I identify the model by assigning the variables specified in Table 2 toonly one equation+

To make the results comparable to previous work, I follow Przeworski andVreeland and Vreeland44 in assigning several macroeconomic aggregates normal-

43+ Poirier 1980, 213+ Earlier versions of the models reported here were unstable until the equa-tions were pinned down by a few instruments with strong effects, but the results then became robust tothe inclusion of additional instruments+

44+ See Przeworski and Vreeland 2000; and Vreeland 2003+

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ized by gross domestic product ~GDP! to the government’s decision, while assign-ing the same aggregates in absolute terms to the IMF’s approval decision+45 Thesubstantive import of this assumption is that the IMF may have special concernsabout the impact of a country’s instability on international markets that the country’sown government does not share+ I expect that governments’ interest in participat-ing in programs depends on the frequency of past participation, which allows forthe possibility of recidivism+46 In addition, governments of poorer countries andthose that are not sustained by substantial inflows of foreign direct investmentshould have more interest in participating in a program+ Furthermore, I expectthat governments will be more willing to assume the political risks of unpopularpolicies shortly after winning an election+47

An important identifying assumption for the approval equation is that the IMF’swillingness to extend a program depends on a country’s technical capacity to imple-ment one, but a country’s interest in participating does not+ I derive a measure ofinstitutional capacity from the pattern of missing data in the information reportedto the IMF and published in International Financial Statistics+48 Principal compo-nents analysis of the pattern generates two variables+ institutional weakness

45+ Vreeland 2003 identifies his model by assuming that countries care about the size of economicaggregates relative to their GDP, whereas the IMF, which is concerned about global stability, is con-cerned about macroeconomic aggregates only if their absolute size is large+ I test for this possibilitybut do not find support for it+

46+ Bird, Hussain, and Joyce 2004+47+ See Przeworski and Vreeland 2000; Vreeland 2003; and Dreher 2004+48+ For each of eighteen key variables, I coded a dummy variable to take the value 1 if data is

missing in a given month and zero otherwise+ The eighteen variables were: imports, exports, currentaccount, the interest rate on treasury bills, the change in the money supply ~M1!, the exchange rate,international reserves, inflation, aggregate domestic credit, claims on the central government, centralbank claims on the central government, central bank foreign liabilities, budget balance, net domesticborrowing, net foreign borrowing, foreign debt, commercial bank foreign liabilities, and commercialbank reserves+ Principal components analysis of these series revealed two main components ~eigenval-ues of 10+0 and 2+3, respectively!, which together account for 68 percent of the variation along theeighteen dimensions+

TABLE 2. Identifying conditions

Government decision to enter a program IMF decision to support a program

Foreign debt0GDP Foreign debtCurrent account deficit0GDP Current account deficitBudget deficit0GDP Institutional weaknessPast participation in IMF programs Institutional effortGDP per capita U+S+ aid recipientNet foreign direct investment UN voting ~affinity with U+S+!Proximity to an election year IMF quota

OECD aid

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is measured by the first principal component of the missing data, which capturesthe overall prevalence of missing data+ The second principal component has a mixof positive and negative loadings, and a larger value appears to represent the insti-tutional effort that countries make to comply with IMF reporting standards+49

In addition, following a growing literature that shows that IMF lending dependson ties with the United States and other leading IMF shareholders, I allow for thepossibility that the Fund’s willingness to support a program will be affected byU+S+ foreign aid to the borrowing country, the association in UN voting patternsbetween the potential borrower and the United States, and development aid fromother countries of the Organization for Economic Cooperation and Development~OECD!+50 Also, the size of a country’s claim on IMF resources ~IMF quota! mayaffect the Fund’s willingness to extend a program+

The results, presented in Table 3, indicate that country decisions to apply forIMF support are related to long-term capital needs, macroeconomic vulnerability,and the timing of elections+ All else equal, poorer countries ~those with lower percapita incomes! are more likely to seek IMF assistance+ Foreign exchange reservesplay an important role in seeking IMF support+ The average country in the sampleheld 3+5 percent of GDP in reserves, but a country that held one standard devia-tion more in reserves, or 65+5 percent of GDP, was 54 percent less likely to applyfor an IMF program+ Higher foreign debt also appears to motivate countries toturn to the Fund, but the quantitative effect is small+ A larger fiscal deficit ~smallerfiscal balance! appears to steer a country away from the Fund, suggesting thatgovernments expect conditionality to be onerous in a situation of rising publicdebt+51 The average country in the sample had a budget deficit of 1+6 percent ofGDP, but a country that had a deficit one standard deviation greater, or 5+5 per-cent, was 14 percent less likely to apply for a Fund program+ Similarly, althoughlow reserves move a country toward a Fund program, countries with deterioratingforeign reserves appear to be reluctant borrowers ~ p � +07!+ Domestic politicalconstraints appear to weigh heavily on borrowers’ minds, because a government is42 percent more likely to apply in the year after it has won an election+ Democra-

49+ The interpretation of the first component is clear, because all of the loadings are positive, butthe interpretation of the second component ~institutional effort! is more complex+ It has positiveloadings for budget balance, foreign and domestic borrowing, and foreign debt, but negative loadingsfor less frequently available macroeconomic and banking indicators+ Countries in the sample typicallyreport the variables that load positively and not those that load negatively, so the typical pattern gen-erates a negative value for this component+A larger value, conversely, represents the tendency to reportdata that low-capacity governments would not ordinarily generate without prodding from the IMF+

50+ See Thacker 1999; Barro and Lee 2002; and Dreher and Jensen 2003+ A series of influentialstudies support the argument that the United States uses aid as an instrument of foreign policy+ SeeBoone 1996, Alesina and Dollar 2000; and Alesina and Weder 2002+ A recent analysis shows that thenonpermanent members of the U+N+ Security Council receive disproportionate shares of U+S+ aid, espe-cially before critical votes; see Kuziemko and Werker 2006+

51+ Przeworski and Vreeland 2000; and Vreeland 2003 found an opposite effect+ Since their sampleis for an earlier period, it is possible that the difference reflects the increased role of fiscal condition-ality in the 1990s+

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cies, however, show more interest in program participation, suggesting congru-ence between democracy and economic reforms+

Recipients of U+S+ aid are 39 percent more likely to have their programs approved+Strikingly, aid from other members of the OECD does not have a discernible influ-ence on IMF decisions to approve programs+ institutional weakness, measuredby the prevalence of missing data, is negatively related to IMF decisions to extendprograms, implying that general weakness in institutional capacity reduces the IMF’swillingness to support a program+ A one-standard deviation increase in the preva-

TABLE 3. Participation in IMF programs, 1990–2002 ( full model)

Country decisions IMF decisions

Variables CoefficientStandard

error p CoefficientStandard

error p

reserves/gdp �0+0087 0+0025 0+00 0+0021 0+0016 0+19D reserves 0+0004 0+0002 0+07 �9+0E�06 1+7E�05 0+60D exchange rate �0+0008 0+0012 0+52 0+0691 0+0297 0+02polityiv 0+0238 0+0125 0+06 0+0169 0+0120 0+16seats 0+0000 0+1665 1+00 �0+0762 0+2555 0+77left_right 0+0492 0+0493 0+32 0+0208 0+0402 0+60no. in coalition 0+0616 0+0416 0+14 �0+0228 0+0236 0+33number under �0+0093 0+0049 0+06 0+0108 0+0082 0+19

gdp per capita �0+0001 4+98E�05 0+01fiscal bal/gdp 0+0338 0+0154 0+03current acct./gdp 0+0005 0+0008 0+56foreign debt/gdp 5+0E�10 1+2E�10 0+00fdi �5+2E�12 1+10E�11 0+64prior participation �0+1802 0+4478 0+69election 0+3502 0+1844 0+06

current acct. 0+0001 0+0001 0+39foreign debt 1+64E�11 2+2E�11 0+45institutional weakness �0+1144 0+0475 0+02institutional effort 0+0939 0+0364 0+01u.s. aid 0+3314 0+1667 0+05un voting (s-u.s.) �0+0353 0+1218 0+77foreign aid (dac) �6+4E�05 0+0002 0+75quota �0+0006 0+0006 0+27spline1 0+0134 0+0214 0+53 �0+0424 0+0169 0+01spline2 �0+0172 0+0071 0+02 0+0001 0+0040 0+99spline3 0+0101 0+0036 0+01 0+3240 0+8436 0+70Constant �0+8590 0+4375 0+05 �1+9803 0+3255 0+00r 0+9076 0+2519 0+29

Notes: Partial observability bivariate probit+ Robust standard errors are adjusted for clustering by country+ Number ofobservations � 14,440 ~country months!+

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lence of missing data reduces the probability of program approval by 28 percent+Conversely, a government that makes an effort to comply with IMF reporting stan-dards raises the probability that it will be approved for a program: the variable insti-tutional effort is positively related to program approval, with a one-standarddeviation shift increasing the probability that the Fund grants a program by 16 per-cent+ Finally, countries that have substantially devalued their exchange rates, or thathave recently suffered from exchange rate crises, are more likely to be approvedfor IMF programs, perhaps because program targets are more likely to be achieved+

These results support one hypothesis derived from the bureaucratic rent-seekingperspective: governments prefer to wait until after elections to turn to IMF pro-grams, to avoid electoral accountability for the short-term pain of reforms+ How-ever, several other bureaucratic rent-seeking hypotheses are rejected+ Vreelandargues that governments with large numbers of coalition members should be eagerto participate in IMF programs to commit themselves to carry out reforms thatwould otherwise be blocked by veto players52; in contrast, the IMF should be lessinterested in initiating programs under those circumstances+ I find no support foreither hypothesis+ Vreeland further argues that the Fund’s interest in pushing loansshould be reflected in a decreasing probability of extending new programs whenmany countries are concurrently participating, as its interest in expanding its influ-ence becomes satiated and its resources become tightly stretched+ I find no sucheffect+

In sum, countries are eager to apply when their need for emergency financing issevere, but reluctant when the rates of change of macroeconomic aggregates indi-cate that the Fund will prescribe tough fiscal and monetary discipline+ Democra-cies are more likely to apply for programs, but will generally wait until after anelection to come to grips with politically risky reforms+ The probability that theIMF will approve a program is higher when the borrower is a recipient of U+S+foreign aid, when the country has high levels of institutional capacity and alsomakes an effort to collect the data that the IMF requires, and when the borrower’scurrency has recently depreciated+ These results provide a plausible basis for usingthe predicted probabilities as measures of the interest of the borrower and the will-ingness of the IMF, respectively, to initiate an IMF program+

The Scope of Conditionality

The dependent variable is the number of categories of conditions subject to test inthe current month, ranging from 0 to 19, and I use a negative binomial event countmodel to analyze variation in the scope of conditionality+53 Observations are defined

52+ Vreeland 2003+53+ Negative binomial regression is a generalization of the Poisson event count model+ Unlike the

Poisson, it does not assume that the rate of occurrence, l, is constant across events in an observation+

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whenever new information about conditionality appears in the data set: when anew program is initiated, when a program review occurs, and when a disburse-ment is scheduled or actually takes place+

Informal Governance

I have shown above that countries that received U+S+ foreign aid were more likelyto be approved for IMF programs+ I now turn to a more direct test of this hypoth-esis, and I find that countries that receive substantial amounts of U+S+ foreign aidare also subject to dramatically reduced degrees of conditionality+ This effect,indeed, is substantively important enough to overwhelm the effects of all otherfactors in the countries that are the largest aid recipients+ This is not the full story,however+ Closer examination of these effects indicates that the United States inter-venes in the design of conditionality selectively, rather than systematically+ TheFund enjoys conditional delegation of authority to design conditionality+ TheUnited States becomes involved only when an important borrower has a pressingneed for IMF support, and is less willing to intervene on behalf of countries withweak institutional capacity+

The first model presented in Table 4 indicates that U+S+ aid is associated withnarrower conditionality+ The second model interacts U+S+ foreign aid with threemeasures of vulnerability: trade openness ~reflecting dependence on continuedaccess to international markets!, debt service, and short-term debt ~represent-ing rollover risk!, and institutional weakness+ These interactive effects requireinterpretation, so Figure 2 presents substantive effects of the variables based onModel 2+

The entries in the cells are the substantive effects of an increase in U+S+ foreignaid by one standard deviation; because of the interactions, these effects depend onthe vulnerability and institutional capacity of the borrower+ U+S+ aid is associatedwith reduced conditionality, but only when countries are at least as vulnerable asthe average program participant—that is, when debt service is at least 18 percentof exports, at least 10 percent of debt is short term ~has a maturity of one year or

Instead, it is parameterized by the gamma distribution, with E~l! � w and n~l! � w~s 2 � 1!+ Thismeans that the marginal probability of observing an additional condition can vary within a particularmonth; for example, some conditions could be more or less likely if other conditions are called for+The distribution of the dependent count variable is given as:

fnb~ yi6l,s 2 ! �

G� l

s 2 � 1� yi�

yi !G� l

s 2 � 1��s 2 � 1

s 2 �yi

~s 2 !�l0~s2�1!

where G is the gamma distribution; see King 1989, 51–52+

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less!, and trade accounts for at least two-thirds of GDP+ I interpret this to indicatethat the influence represented by aid is a resource both for the United States andfor the aid recipient, and recipients are reluctant to spend this resource when it isnot necessary to do so+When they are not vulnerable, aid recipients choose not todraw on their influence by calling on the United States to influence the Fund+Whenvulnerability is high, however, the effect of U+S+ influence can be large+ In a high-capacity state with high vulnerability, a one standard-deviation increase in U+S+aid has the effect of reducing the scope of conditionality by one-third+

On the other hand, borrowers that are less vulnerable than the average programparticipant according to all three measures are subject to greater conditionality:the estimates indicate that the effect of one standard deviation of U+S+ aid in alow-capacity state with low vulnerability is to expand the scope of conditionalityby about 20 percent+ When the United States does not interfere on behalf of acountry that has substantial latent influence, the Fund management may seize theopportunity to impose a robust set of conditions that will provide strong groundsfor suspending financing in the future in the event of noncompliance+ It is impor-tant to note, however, that the number of observations of IMF programs in cellswith low vulnerability on all dimensions is relatively small and, hence, this effectrefers to relatively few recipients of IMF support+

The United States appears to be less willing to intervene on behalf of low-capacity states ~those with substantial missing data!, which are more penalized foraid when not vulnerable and less advantaged by their influence with the UnitedStates when vulnerable+ This suggests that the substantive significance of U+S+ for-eign aid depends on the strength of the recipient state+ Strong states are more nearlyequals, and the fact that they are important enough to the United States to receive

FIGURE 2. Effects of U.S. foreign aid on scope of conditionality

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aid indicates that they have leverage that they can use to demand concessions+Weak states in Africa, in contrast, may depend on foreign aid for 10 percent ofGDP and as much as two-thirds of government consumption, and are in no posi-tion to make demands+

A simple association of U+S+ foreign aid with narrower conditionality might beattributed to omitted variables, such as state capacity or wealth+ I have controlledfor the obvious suspects; nevertheless, the conditional effects predicted by the infor-mal governance model provide more conclusive evidence+ The informal gover-nance model provides a causal mechanism to explain why U+S+ influence is turnedon or off by international financial vulnerability, and it is difficult to explain suchconditional effects in terms of an omitted variable+

IMF Objectives

As noted above, the bivariate probit model employed at the selection stage gener-ates two predicted probabilities: the marginal probability that a country applies tothe IMF for support, and the marginal probability that the IMF is willing to approvea program+ I use these predicted values as measures of bargaining power+54 Thebureaucratic rent-seeking model offers a clear-cut prediction about the first of thesevariables: the IMF imposes the maximum possible level of conditionality, so coun-tries that are motivated to accept IMF support are compelled to accept more con-ditions+55 The results contradict this expectation, however+ Countries that are eagerto receive loans accept no more restrictions than those that are reluctant+ Instead, Isee a pattern in which the IMF imposes more conditions on reluctant borrowersand fewer on countries that are eager to participate+ Perhaps IMF staff judge thatcountries that are highly motivated to seek IMF loans also have strong internalincentives to carry out reforms without explicit IMF conditionality, and that it isthe reluctant reformers who require extensive surveillance+ Indeed, formal workhas shown that under conditions of incomplete information it is optimal to usemore flexible forms of conditionality when the borrower is believed to be moti-vated to reform, in order to take advantage of local knowledge+56 For present pur-poses, however, it is significant that the IMF refrains from imposing maximumlevels of conditionality when it has the opportunity to do so; this is behavior thatis inconsistent with the image of an out-of-control agency seeking to expand itsinfluence+

54+ Because these probabilities are estimated, it is necessary to correct the standard errors in thesecond stage for the variance of the estimated regressors+ In the absence of an analytical solution forthe particular combination of models used here, I use a bootstrap approach+ Bootstrapping involvesdrawing multiple samples of size N from the data with replacement, replicating the procedure multipletimes, averaging the coefficients and calculating the standard errors from the empirical distribution ofbeta+

55+ Dreher and Vaubel 2004+56+ Marchesi and Sabani 2008+

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The effects of the probability of program approval are consistent with a bar-gaining model—programs that the Fund is inclined to approve carry fewerconditions—but a bargaining model suggests that the interpretation of these effectsdepends on the factors that make program approval likely+ The bureaucratic rent-seeking perspective predicts that the IMF should offer programs with fewer con-ditions when its organizational incentives make it disposed to make loans, whichwould account for the association between a high probability that the IMF grantsa program and reduced conditionality+57 However, the results of the first-stageanalysis did not support bureaucratic rent-seeking hypotheses about the IMF’smotivations for making loans+58 On the other hand, the research design makespossible a direct test of the causal mechanism of informal governance+ I foundabove that the most impressive influence on the IMF’s willingness to lend waswhether a country was a recipient of U+S+ foreign aid; now I find that countriesthat were likely to be granted programs were constrained on fewer policy dimen-sions+ This gives the coefficient in the second stage an interpretation consistentwith the earlier findings about the constraining effect of U+S+ aid: the United Statesintervenes to ensure favorable treatment for valued allies, and this underminesthe Fund’s bargaining position+ Countries that are favored in the distribution ofIMF programs receive more attractive terms because they know that the Fund’sthreat to withhold support if they do not accept its policy recommendations isnot credible+

Another important dimension of bargaining power is the borrower’s need forexternal financing+ Countries that use a large portion of their exports for debtservice and that owe a large proportion of their foreign debt in short-term instru-ments ~resulting in greater rollover risk of external financing! should be particu-larly dependent on nonmarket sources of financing+ Indeed, I found above thatcountries with significant external debt are more likely to seek IMF support, andthey should therefore be willing to accept more conditions in return for thatsupport+ The IMF, on the other hand, aware of its strong bargaining position,should be able to push for far-reaching reforms in this situation+59 The bureau-cratic rent-seeking perspective indicates that the Fund should not hesitate to exploitthese opportunities to extract extensive reform commitments+ Similarly, countrieswith more open economies are likely to be more vulnerable to international sup-ply and demand shocks, and the IMF should therefore enjoy a bargainingadvantage+

57+ See Vaubel 1991; and Dreher and Vaubel 2004+58+ The IMF does lend more readily to countries that consistently publish data, that make an effort

to collect the data that the IMF demands, and that have devalued their currencies, all factors that shouldsatisfy organizational incentives to approve programs only if they are likely to be successful+ How-ever, since these factors also indicate that less conditionality may be necessary for technical reasonsthat have nothing to do with organizational biases, they do not represent clean tests of a bureaucraticrent-seeking hypothesis+ As noted above, other bureaucratic rent-seeking hypotheses about loan origi-nation were rejected+

59+ See Mosley 1987; and Stallings 1992+

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The results again reject these expectations, however+60 When these forms of vul-nerability have any effect, it is to reduce rather than to increase the incidence ofconditionality+ As discussed above, vulnerability interacts with U+S+ foreign aid indetermining the conditionality outcome, so a complete discussion of the effects ofvulnerability requires evaluation of these interaction effects+ Figure 3 explores thesubstantive effects of various measures of vulnerability, which depend on the levelof U+S+ foreign aid+ In each column, one vulnerability measure varies by one stan-dard deviation while the others are held constant+

In no case do countries receive more ambitious program targets because theyare dependent on foreign trade, are heavily indebted, or are in imminent need ofdebt restructuring; if these factors affect conditionality, it is only to reduce it+ Thus,contrary to popular criticisms of Fund policies during the East Asian crisis of 1997,international vulnerability has not, on average, led to more conditionality+ Whenthe IMF faces a particularly vulnerable country, it typically refrains from impos-ing the maximum possible degree of conditionality+ However, none of the threevariables that indicate vulnerability has any effect on conditionality in countriesthat receive no U+S+ foreign aid, which implies that vulnerability affects condition-

60+ I also hypothesized that countries with large populations or large IMF quotas, which roughlytrack the size of the national economy, trade and reserves, and capture a country’s weight in IMFboard votes, would enjoy extra bargaining leverage+ However, there is no evidence that these variableshave any effect+

FIGURE 3. Effects of vulnerability on scope of conditionality

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ality only because it triggers the latent effects of U+S+ influence+ In countries thatdo receive generous amounts of U+S+ aid, these forms of vulnerability are reflectedin substantially reduced degrees of conditionality+ Countries that are both vulner-able to sudden stops of financing and influential in the United States find ways tobring their influence to bear on the IMF, and this is reflected in the pattern ofconditionality+

The effect of one form of vulnerability appears to support the bureaucratic rent-seeking view, but the two-stage research design provides explanatory leverage thatsuggests an alternative explanation+ Poor countries receive programs with moreextensive conditions+ Dreher and Jensen61 have a similar finding and argue thatpoor countries have a weak bargaining position and are compelled to accept moreconditions+ If so, I ought to find this result reflected through the effects of mymeasures of bargaining power+ I do indeed find that poor countries more activelyseek support, which appears to support the view that the IMF is able to insist onextensive reforms when the recipient has intense need for a program+ However, asnoted above, the motivated borrowers that actively seek support are subject to lessextensive conditionality, rather than more, which contradicts the bureaucratic rent-seeking hypothesis+ Thus, the effect of poverty cannot act through bargaining+Instead, the most plausible interpretation is that IMF staff believe that sweepingreforms are more appropriate or necessary in low-income countries than in middle-income countries+

Borrower Objectives

The effects of domestic political conditions and state capacity, furthermore, rejectthe domestic variant of the bureaucratic rent-seeking hypothesis, which held thatgovernments use the Fund strategically to misrepresent their preferences to vot-ers+ To the contrary, the evidence points to conventional bargaining effects, withbargaining strength deriving from domestic constraints+ First, countries with dem-ocratic institutions receive markedly fewer conditions: an increase of one standarddeviation on the Polity scale, or 5+5 points on a 21-point scale, results in an 8percent decrease in the number of categories of conditions+ This finding is subjectto two possible interpretations, both consistent with a bargaining hypothesis+ Itmay be that the Fund is sensitive to the criticism that its conditionality endangersthe fragile, new democracies in many borrowing countries+ Alternatively, it couldbe that democratic governments insist on more lenient programs because they facemore domestic policymaking constraints than authoritarian governments+ In eithercase, the IMF apparently accommodates the constraints of democratic politics+

Controlling for the degree of democracy, presidential systems receive 7 percentfewer conditions than parliamentary democracies+ This effect is consistent with a

61+ Dreher and Jensen 2007+

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two-level bargaining interpretation: presidents lack some of the institutional advan-tages for legislating reform that prime ministers enjoy, and domestic weakness isassociated with international bargaining power+62 Again, this evidence contradictsthe hypothesis that presidents generally turn to the Fund to tie their hands vis-à-vis the legislature because they lack the legislative powers of prime ministers+Certain presidents have clearly done this—Russia’s Boris Yeltsin comes to mind—but in the aggregate, presidents bargain with the Fund and use divided govern-ment as an excuse to limit their concessions+ Yeltsin used this strategy, as well+

Political coalitions, which play an insignificant role in determining participationin IMF programs, nevertheless figure prominently in program design+ Fragmentedcoalition governments constrain, rather than expand, the scope of conditionality+Each additional party added to a coalition government reduces the breadth of con-ditionality by approximately 2 percent+ In addition, governments with leftist ideol-ogies receive less expansive reform programs+ Leftist governments are more resistantto expansive proposals for sweeping reform, and the bargaining outcome reflectstheir preferences+ I see no evidence that left-wing governments are particularly anx-ious to establish credibility or to avoid the policy consequences of populist elec-toral mandates+63

Finally, state capacity variables provide further evidence of bargaining+ Control-ling for per capita income levels, the weak states in sub-Saharan Africa received21 percent fewer conditions+ Lending facilities with concessional interest rates ~SAF,ESAF and PRGF!, available only to low-income countries with generally weakstates, are associated with approximately 6 percent narrower conditionality+ Fur-thermore, countries with one standard deviation lower administrative capacity thanthe mean received 4 percent fewer conditions+ This may indicate that IMF staffadvocate narrower programs because more ambitious ones would be likely to fail,or it may indicate that countries with weak states leverage their weaknesses intobargaining strength+ In either case, weak states bargain for reduced conditionalityrather than using the IMF as a cover to implement expansive reforms+

Conclusions

The trade-off between autonomy and legitimacy dominates proposals to reformthe IMF and to redistribute voting shares among its members, but the debate isinadequately informed by empirical data+ Academic and popular treatments alikeassume that IMF conditionality is inflexible, failing to take into account the eco-nomic circumstances in which countries find themselves, and failing to adjust tothe political realities on the ground that may make dangerous nonsense of idealis-tic policy reforms+ Policy briefs representing the bureaucratic rent-seeking view

62+ See Putnam 1988; Mansfield, Milner, and Rosendorff 2000; and Martin 2000+63+ See Milesi-Ferretti 1995; and Cukierman and Tommasi 1998+

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see the IMF as excessively autonomous, with a tendency to mission creep+ Thisstudy rejects these conclusions+ I find that conditionality varies widely, and thatthe Fund refrains from maximizing the scope of conditionality when countries aremost in need of IMF resources+ In addition, whether by design or by necessity,conditionality accommodates domestic political constraints+ The evidence sug-gests that the dangers of an autonomous IMF have been greatly overstated, andthat the limitations on the Fund’s autonomy are a more serious concern+ The Fundtypically exercises autonomy, but that autonomy can be revoked when the UnitedStates exercises its informal influence over the process of program design+ Thisintervention distorts the application of conditionality and contributes to the IMF’scredibility problems+ The danger posed by delegating powers to international orga-nizations is that they will be captured by the most powerful state in the system+

This analysis supports four specific hypotheses derived from a model of infor-mal governance+ U+S+ intervention should reduce, rather than increase, condition-ality; intervention should be used selectively, rather than systematically; interventionshould only be offered to strategically important countries; and intervention shouldbe limited to countries that are vulnerable enough to seek it+ Countries that enjoythe strong support of the IMF’s largest shareholder, the United States, enjoy asubstantial bargaining advantage because the IMF cannot credibly threaten to with-hold support from them+ A direct test of these causal links confirms this interpre-tation: countries that receive U+S+ aid are 39 percent more likely to be offeredIMF programs, and countries that are more likely to be offered a program acceptfewer categories of conditions+

Associations between variables are susceptible to multiple interpretations, soconditional hypotheses are tighter tests of models+ The model implies that coun-tries are reluctant to draw on their reserves of influence with the United Stateswhen their need for financing is not urgent, leaving the IMF free to negotiate con-ditionality according to its own objectives+ This hypothesis is confirmed by theresult that U+S+ aid only constrains conditionality when the borrowing country isrelatively vulnerable to international shocks compared to the sample of programparticipants+ Furthermore, international vulnerability is found to reduce, rather thanincrease, the application of conditionality—but only in countries that receive U+S+foreign aid+ I describe this situation as conditional delegation: the IMF is autono-mous when the borrower is unimportant to the United States or the borrower isunwilling to spend the influence needed to call upon U+S+ assistance in dealingwith the Fund+ The effect of U+S+ aid is similarly weakened when the borrowerhas weak institutional capacity, indicating that the relationship between aid donorsand recipients depends on the strength of the recipient state+ Strong states can bar-gain with the United States on a more nearly equal footing; weak states acceptwhat they must+

If correct, the informal governance model offers an explanation for the crisis oflegitimacy currently facing the IMF+ The United States has exerted influence inways that undermined the legitimacy of the IMF in recent years in a series ofhigh-profile cases involving Mexico, Russia, Ukraine, Indonesia, Korea, Brazil,

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Argentina, and Turkey+ Many of these missteps took place in phases of IMF pro-grams other than the design of conditionality—for example, in the cases of Mex-ico and Korea, the amount of access to IMF resources was critical+ In the cases ofRussia, Ukraine, Argentina, and Turkey, U+S+ pressure led the IMF to relax theenforcement of conditionality, which provided temporary relief to unstable gov-ernments, but ultimately caused these countries’ economic policies to fail+ Mean-while, although borrowing governments appreciated U+S+ help managing the Fund,resentment grew over the political and economic quid pro quos that the UnitedStates extracted in return for its leverage+

As a consequence, most of these countries and many others have chosen to exitthe IMF-sponsored insurance regime and self-insure against international finan-cial risks by undervaluing their exchange rates and accumulating internationalreserves+ The Fund lives on the interest it charges on its loans and now finds itselfvirtually without customers, so it has announced plans to cut its payroll by 15percent+ For the United States, the consequence of the IMF’s unpopularity is theloss of a convenient conduit of influence+ The abuse of informal governance pro-cedures tends to undermine the legitimacy of international institutions, and theexploitation of asymmetric interdependence tends to lead to its erosion+ For theinternational system, the consequence of the IMF’s legitimacy crisis is the weak-ening of a key advocate for open markets, economic reform and financial stability+

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The Scope of IMF Conditionality · The Scope of IMF Conditionality Randall W+ Stone Abstract...

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